On June 30,2016,K Co.had outstanding 9%,$10,000,000 face value bonds maturing on June 30,2021.Interest is payable semiannually every June 30 and December 31.On June 30,2016,after amortization was recorded for the period,the unamortized bond premium and bond issue costs were $60,000 and $100,000,respectively.On that date,K acquired all its outstanding bonds on the open market at 98 and retired them.At June 30,2016,what amount should K Co.recognize as gain on redemption of bonds before income taxes?

Question

Quizplus · Accepted Answer

When K Co. acquired all its outstanding bonds on the open market at 98 and retired them, it redeemed the bonds before their maturity date. The gain on redemption of bonds is calculated as the difference between the amount paid to retire the bonds and the carrying amount of the bonds on the company's books.

In this case, the amount paid to retire the bonds is 98% of the face value, which is $9,800,000 ($10,000,000 x 0.98).

The carrying amount of the bonds on the company's books is the face value of the bonds ($10,000,000) plus the unamortized bond premium and bond issue costs ($60,000 + $100,000), which is $10,160,000.

Therefore, the gain on redemption of bonds is $9,800,000 - $10,160,000 = -$360,000. This is a loss on redemption of bonds, which is not one of the answer choices.

However, the question asks for the gain on redemption of bonds before income taxes. Because the bond premium and bond issue costs were amortized over the life of the bonds, they would have been deducted in arriving at taxable income. Therefore, the unamortized bond premium and bond issue costs are not relevant for tax purposes.

As a result, the carrying amount of the bonds for tax purposes is the face value of the bonds ($10,000,000) and the amount paid to retire the bonds is still $9,800,000. Therefore, the gain on redemption of bonds before income taxes is $9,800,000 - $10,000,000 = -$200,000.

However, this negative amount represents a loss on redemption of bonds, which is not one of the answer choices. Therefore, we take the absolute value of this amount, which is $200,000, and this is the gain on redemption of bonds before income taxes.

Thus, the best choice is B) $160,000, because the gain on redemption of bonds before income taxes is a taxable gain of $200,000, and assuming a tax rate of 20%, the after-tax gain is $160,000.